Money and Its Functions

Definition of Money –

Professor D.H. Robertson defines money as “anything which is widely accepted in payment for goods or in discharge of other forms of business obligations.”

According to Crowther, “Money can be defined as anything that’s generally acceptable as a means of exchange and that at the same time acts as a measure and a store of value.”

There are two important things to note about money. First, Money has been defined in terms of functions it performs. That is, money is anything which performs the functions of money. Second, any essential requirement of any kind of money is that it must be generally acceptable to every member of the society.

Money has a value for ‘A’ only when he thinks that ‘B’ will accept it in exchange for goods. And money is useful for ‘B’ only when he confident that ‘C’ will accept it in exchange for goods or for settlement of debts.

General acceptability is not a physical quality possessed by a good. General acceptability is a social phenomenon and is conferred upon a good when the society by law or convection adopts it as a medium of exchange.

Functions of Money –

Money has four main functions –

1. Medium of Exchange

2. Measure of Value

3. Standard of Payment

4. Store of Value

Explanation of Functions –

1. Medium of Exchange –

The most important function of money is that it serves as a medium of exchange. In the barter economy an excellent difficulty was experienced in the exchange of products because the exchange in the barter system required double coincidence of wants. Money has removed this problem.

Now a person A can sell his goods to person B for money and then he can use that money to buy the goods he wants from others. As long as money is acceptable, there will be no problems in the process of exchange.

The function of medium of exchange that money performs has become possible because money has enabled us to separate the act of buying from the act of selling and avoids double coincidence of wants.

By serving as a very convenient medium of exchange money has made possible the division of labour in the modern economy.

2. Measure of value or A Unit of Account –

Another important function of money is that it serves as a standard measure of value or a unit of account. In barter economy there was no common measure of value in which the values of different goods could be measured and compared with each other. Money has solved this problem. Money serves as a yardstick for measuring the value of goods and services.

In barter system, value of different goods were expressed and measured in terms of quantities of each other. Money has also solved this problem. As the value of all goods and services is measured in a standard unit of money, their relative values can be easily compared.

For example, rupee is the basic unit of account in India for measuring economic values. Almost all prices of goods and services, wages of labour, rent of land, interest on capital, prices of commodities, metals, real estate are expressed and measured in rupees. Measuring values of all goods and services in a single uniform account simplifies the comparison of values of different goods and services.

3. Standard of Deferred Payment –

Another function of money is that it serves as a standard for deferred payments. Deferred payments are those payments which are to be made in the future. If a loan is taken today, it would be paid back after a period of time. The amount of loan is measured in terms of money and it is paid back in money. Money performs this function of standard for deferred payments because its value remains more or less stable.

If the prices are falling, then the value of money is rising. There is an inverse relationship between the prices and value of money. When there is a sever inflation or deflation, money ceases to serve as a standard of deferred payments.

4. Store of Value –

Lastly, money acts as a store of value. Money being the most liquid of all assets is convenient form to store wealth, which means money can be held as an asset. Store of money function is also called ‘Asset function of money’. Therefore, it is essential that the good chosen as money should be easily stored without deterioration or wastage. That is why gold was popular in the past as a store of value. Gold could be kept safely without deterioration. But in modern times even paper money can be kept as deposits in banks to serve as asset.

There are other assets like houses, bonds, shares etc, in which wealth can be stored. But money serves this function with a difference. Money being the most liquid of all assets has the advantage that an individual can buy with it anything at anytime. But this is not the case with other assets. Other assets like houses, bonds, shares etc. have to be sold first and converted into money and only then they can be used to buy other things.

Money has removed the difficulties of barter system. It has facilitated trade and has made possible the complex division of labour and specialization of the modern economic system. Without the utilization of money, modern economy won’t run smoothly and therefore the production will get a significant setback. Due to these reasons, monetary economy is preferred over the barter economy.